We are keeping our NEUTRAL call on the telecommunication sector. TELENOR and AXIATA have opened talks about a potential non-cash merger of their telecom and infrastructure assets in Asia, in which the former would take a majority stake. We are POSITIVE on the proposed transaction in view of the potential significant operational synergies despite it just at the preliminary stage. We believe both AXIATA and DIGI’s share price may act postiviely over the near term in view of the attractive proposal. All in, we made no changes to our Telcos’ earnings forecasts and target prices. DIGI (MP, TP: RM4.55) and OCK (OP, TP: RM0.650) remained our preferred picks in the big/mid-cap telecom space.

Mega merger in the making. TELENOR Group and AXIATA Group Berhad announced they are in discussions regarding a potential non-cash combination of their telecom and infrastructure assets in Asia (MergeCo), in which TELENOR would take a majority stake. It is anticipated that TELENOR, based on equity value, will own 56.5% in MergeCo and AXIATA will own 43.5% and both parties acknowledging that this is preliminary subject to adjustments and due diligence (set to be completed in 3Q19). This proposed transaction will be based on the principle of merger of equals between AXIATA and TELENOR. The intention is to create a commercial board governed company, combining the best-in-class talents, capabilities and culture of AXIATA and TELENOR in the MergeCo.

Discussion to merge Asian operations. The MergeCo will have controlling operating subsidiaries in nine countries (with 6 being # 1, 2 being #2 and 1 being #3 in their respective markets) with a combined total population of more than one billion people and 300m customers. The MergeCo will have its operational headquarters in Kuala Lumpur with the majority of functions and is to be listed at an international stock exchange as well as on Bursa Malaysia. TELENOR’s Asian footprint includes Thailand, Malaysia, Bangladesh, Pakistan and Myanmar while AXIATA has been operating companies in Malaysia, Bangladesh, Cambodia, Nepal, Sri Lanka and Indonesia, as well as the tower business through edotco. Pro-forma revenue and pre-synergy EBITDA of the combined entity is approximately RM50b and RM20b. Separately, Robi Axiata Ltd, a subsidiary of Axiata operating in Bangladesh shall continue to be managed independently by AXIATA post completion of the proposed transaction.

Significant operational synergies are expected to be gained in five core areas (namely, (i) Malaysia champion through capex avoidance and opex efficiencies; (ii) Procument; (iii) Tower via operational synergies, such as increased tenancy, new build optimisation and etc.; (iv) consolidation of HQ to KL; and (v) wholesale, procurement savings from harmonizing roaming rates, scale, etc.) with potential to deliver RM15-20b incremental value to MergedCo. The MergeCo is set to become one of Asia’s largest mobile infrastructure companies operating approximately 60k towers across Asia and rank among the Top 5 players globally. Besides, the MergeCo will take an active role in accelerating technology transformation and digitalisation in Malaysia and across Asia, and plans to establish a Malaysian Research and Innovation centre for state-of-the-art technologies such as 5G, Internet of Things, Artificial Intelligence, Robotics and etc.

Overall positive; hurdles ahead. We are POSITIVE on the above initiatives, although the preliminary discussion has no certainty that it will result in any transactional agreements between both parties. With the limited available information, it’s hard to gauge any valuations for the proposed transaction and the MergeCo. While we feel excited on the above potential operational synergies, there are several hurdles/challenges that need to be addressed. Tops of the lists are the regulatory approvals given the MergeCo is involved in the nine different countries, and thus, subject to different policies and guidelines. Besides, spectrums would be another major concern, especially in Malaysia, as the local authority may be reluctant to award similar spectrums to the same entity. Shareholders’ approvals, meanwhile, may be another hurdle, especially when the valuation is not appealing enough but still requires consents from the shareholders. Lastly, organisational and culture changes could be another challenge in view of both entities having different cultures, which may lead to culture clash.

Maintain NEUTRAL rating. All in, we make no changes to our AXIATA and DIGI’s earnings forecasts for now in view of the limited available information with regards to the above proposed transaction. Besides, we also maintain our other telecom companies’ earnings forecasts, pending their respective 1Q19 results release. Having said that, we believe both AXIATA and DIGI’s share price may act postiviely over the near term in view of the attractive proposal. While we do not have any OUTPERFORM call in the big cap names, we still prefer DIGI (MP, TP: RM4.55) among others in view of its relatively stable earnings prospect coupled with the above-industry dividend yield. We retain our MARKET PERFORM call on AXIATA (TP: RM4.30) and TM (TP: RM3.10) with UNDERPERFORM rating on MAXIS (TP: RM4.90). We continue to favour OCK (OP, TP: RM0.650) in the mid-cap segment in view of its: (i) healthy cash flow on the back of escalating recurring income trend, (ii) ability to ride with the passive infrastructure sharing trend, and (iii) expanding EBITDA margin trend.

Source: Kenanga Research - 7 May 2019